Understanding what factors affect interest rates in Australia can allow you to adopt better budgeting habits before applying for a home loan. This, in turn, can also make it easier for you to decide which type of home loan is better for you. Let’s look at the lending system in Australia, so that you get a good grasp of how this system works before we look at factors that affect home loans.
The Australian Lending System and Home Loans
Basically, the Australian lending system revolves around the Reserve Bank of Australia (RBA). The majority of Australian home loan lenders, such as banks, credit unions and building societies borrow their money from the RBA. When these lending institutions borrow money from the RBA they pay the RBA the official cash rate. The lending institution that you are borrowing money from for your home loan then charges you their advertised interest rate. This rate is typically higher than the cash rate so that the lending institution makes a profit over the term of your home loan.
How Does the RBA Decide on the Official Cash Rate?
The official cash rate is discussed on the first Tuesday of every month, except January. At these meetings, the board of RBA representatives, which include individuals with long-standing economics and banking backgrounds, decide whether the official cash rate should remain the same, be lowered or be increased.
What Factors Do the RBA Board Base Their Decision On?
The RBA board discuss economic indicators and seek to keep inflation in Australia stable and, the Australian economy prosperous. Economic indicators the RBA typically discuss include the following:
The stability of the Australian currency;
The steadiness of employment rates;
The strength of the housing market and home buying and building activity;
Consumer and business spending; and
Australian inflation rates.
How are These Factors Associated With Home Loans?
The RBA typically lower the official cash rate to increase these economic indicators, and vice versa to decrease them. For example, in order to curb consumer and business spending and the buying of homes, the RBA would raise the official cash rate. This slows down spending and also makes it less affordable to buy a home, which, in turn, reduces the rise of inflation.
What is Inflation?
Inflation is defined as an increase in the price of goods and services and too high an inflation rate can reduce the buying power of money, where a dollar buys less as time passes. In this case, the RBA official cash rate works to control the rate of inflation. This is why the rate changes. Typically, the RBA likes the inflation rate to hover between 2 to 3 percent per annum. However, this can change when outside factors, such as extreme global economic activity takes place. This is also why the RBA look at international economic conditions and the stability of financial markets, as well as economic conditions in Australia before making a final decision regarding the official cash rate.
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Written by eChoice